Japan: A Couple of Observations

Japan appears to have made the same mistake twice now. After demonstrating a willingness to confront China over contested territory, it backed down as China seemed to escalate the issue. In a similar vein, Japan was willing to take on the foreign exchange market by selling JPY2.125 trillion yen (confirmed by the MOF today), which appears to be a record one day amount. Japanese exporters and margin accounts reportedly sold into the dollar's gains the BOJ engineered. But that has been it. Japanese officials appeared to have backed off and one official this week was even talking about the virtues of a strong yen. The dollar fell every day last week against the yen and is now 1 yen lower than it had finished last week.

Yes the intervention was criticized in some quarters, but Japanese officials had to have expected that. Yes the odds of unilateral, even unsterilized, intervention working was also slim, but Japanese officials must have known appreciated that too. Yet they made the judgment call and the lack of follow through can only embolden yen buyers.

Europe, Australia, New Fed Governors Confirmed

The euro was already recovering from the bout of profit-taking in Asia that had seen a low recorded just ahead of support pegged at $1.3550, when news that the European banks borrowed considerably less from the ECB than anticipated and this sent the euro to $1.3675. Recall that 225 bln euro refi operations were maturing today.

These included the rump of the 12-month and 6-month facilities which no longer exist. The ECB offered 3-month funding yesterday. European banks took 104 bln, which was obviously on the light side, but dealers did not want to draw any hard and fast conclusions ahead of today’s 6-day funding made available today. However, banks only wanted to borrow 29.4 bln euros, a little more than half of what a Reuters poll suggested was likely. The combined 135 bln euro in the two days means that there is 90 bln euro less liquidity sloshing around the banking system. This will reinforce official perceptions that the banking system in general in Europe is healing and sufficiently so that it can continue to proceed with a further exit of some of its crisis measures.

FX Overview: Dollar on Backfoot

The US dollar remains on its back foot. The main driver remains the contrast between the likely trajectory of Fed policy in contrast to the ECB. Moody’s 1-notch downgrade of Spanish credit rating and news that Anglo-Irish needs another 6.4 bln euros on top of the 22.9 bln already injected, and possibly another 5 bln on top of that (in a stress case) has been shrugged off and the market has focused on news that European banks are relying less on ECB financing, strengthening the case for the exit that some officials indicated earlier this week. Better than expected Nationwide house prices, month-end demand, no deterioration in the Q3 BOE credit condition assessment has seen sterling lead the charge today and briefly poked above the $1.59 level for the first time in seven weeks. The dollar continues to edge toward the levels that were seen when the BOJ intervened. The low seen on Sept 14-15 was about JPY82.90 and today’s low thus far has been JPY83.16.

CAD-MXN Opportunity

The Canadian dollar has under-performed this month. Among the G10 currencies, only sterling (+2.2%) and the yen (+1%) have done worse than the Loonie, which is up about 2.4% against the greenback. In the current environment, with the prospects of QEII in the US, Canada seems markedly better positioned. Since Bernanke's Jackson Hole speech the Canadian dollar has strengthened but since mid-month, a range trading environment has emerged in the broad CAD1.02-CAD1.04 band.

Technically, a break of CAD1.02 could set the greenback for a test on parity.

The Dollar: Punishment Now, Reward Later

The divergent paths between the ECB on one hand and the Fed, BOE and BOJ on the other hand are very stark. The ECB seems determined to reduce the extraordinary liquidity provisions as they expire at the end of the year. In contrast, the market seems to be acting as if new bond purchases by the Federal Reserve are a done deal. Japan is moving to provide additional monetary and fiscal support. Despite the immediate retort by the BOE’s dissenting hawk Sentance, fellow-member Posen’s comments suggest a dovish consensus may be emerging at the MPC for additional measures, though it might not be quite there yet.

The ECB is the outlier and although in the short-term this is favoring the euro, this may not lay the basis for a sustained rally. The less supportive monetary conditions coupled with tighter fiscal policy will mean that the region is unlikely to generate the growth needed to stabilize debt ratios. So once again the old formula by which the dollar is punished in the short-run for pro-growth policies and later rewarded still seems to be operative.

Quick FX Update

The US dollar remains soft, but the downside momentum seen in recent days appears to be ebbing as new catalysts are awaited. The dollar’s slide is not over and bounces are expected to be shallow and short-lived. The main catalyst continues to current interest rate differentials and their likely trajectory.

The contrast was underscored yesterday as the ECB’s Stark indicated the ECB was still planning an exit from unconventional provisions while the risk of renewed measures by the US and the UK run high. The dollar slipped further against the yen and has now given up roughly two-thirds of the intervention gains, even though the poor outlook for December contained in the Tankan Survey underscores the likelihood that the BOJ responds with additional measures as early as next week. The dollar is softer against most emerging market currencies.

Italy Vote of Confidence Tomorrow

Belgium does has a caretaker government. It has ben unable to form a government since the June election after the previous government collapsed in April. The Netherlands is also struggling to put a coalition together. Italy comes to the fore tomorrow with a vote of confidence in the Berlusconi government that has been shaken by a split in the center-right coalition.

It seems largely like a personality issue between Berlusconi and Fini. Berlusconi is to give a speech to parliament at 9:00 GMT in which he will outline the (optimistically) second half of his term (ends in 2013). There will be a debate about his program and then the confidence vote. The spread between Italy and German has widened out 20 bp over the past five sessions. But this reflects a rally in German bunds, ostensibly on safe haven and less supply, while 10-year Italian bonds are essentially unchanged in this time.

Consumer Lender Woes in Japan

Earlier today, Japan's second largest consumer lender, Takefuji sought legal protection of bankruptcy. The source of its woes, and apparently others in that space, is that the borrowers were overcharged interest.

Japan's regulator says that Japanese consumers were overcharged some JPY4.4 trillion. Takefuji has over a million clients. About 113k have already filed claims to be reimbursed some JPY171 bln from Takefuji and some estimates suggest the figure could rise toward JPY1 trillion. Takefuji is the second largest bankruptcy in Japan this year behind Japan Airlines. There three other large consumer lenders in Japan and their share prices have also fallen. They are Aiful, Promise and Acom. Promise appears to be the only one that owned in part by a bank, which some observers think fare better because of that.

Irish Update

More On Ireland Here

Irish Prime Minister Cowen is trying to reassure the markets. With European central banks reportedly buying Irish bonds (and having appeared to step up their bond purchases a little in recent weeks), the credit default swap market may offer a cleaner read and there the markets are implying the greater risk so far.

But Cowen says not to worry. Ireland is not close to the tipping point and has secured funding through the middle of next year. He is denying speculation that a more costly bailout for Anglo-Irish will drive the government to tap the EFSF. The head of the EFSF would seem to concur, saying that he does not expect any member to tap the EFSF in the coming years. The markets are not as sanguine. While the debate in some countries is about banks being too big to fail, the point we continue to make is that large parts of Europe were more leveraged than the US. The Irish government has already spent almost 20% of GDP to support the banks and more is likely to be forthcoming.

European Woes, but Euro Recovery

ECB’s Stark comments are more important today that increased speculation of a downgrade in Ireland and Spain. In an unusually revealing comment, the ECB’s Stark indicated that a number of the unconventional liquidity measures that are due to expire at the end of the year will in fact do so. This is unusual because it because such policy announcements are more commonly made by ECB President Trichet. It is also unusual in the sense too that it seems to pre-commit to a change in policy. Moreover, Stark’s comment seems to be largely based on one month’s numbers—August money supply and private lending figures.

Dollar Reverses Lower, but Consolidative Session Likely

The US dollar initially extended yesterday’s recovery, but reverse lower in Europe, despite elevated tensions in the periphery of Europe.

Optimistic comments by ECB’s Stark, seeming to signal another step on the exit strategy, German industry association seeing no threat in the current euro level may have helped fuel the euro’s recovery from the test on $1.3380 support.

Euro, Yen and the S&P 500 and Interest Rates: Some Thoughts

In mid-June the dollar-yen rate was correlated with the S&P 500 nearly 91% (r2=0.909). It trended lower until the middle of August, falling to around 31% and recovered to 46% by Sept 10 and has since trended lower and now back to 31%. This is the lower end of the three-month rolling correlation has been since April when it was negative.

The lower trend in the correlation suggests there is another driver at work beside the risk-on/risk-off that has captured the market's imagination. Those other factors could include intervention fears real or imagined. It could be interest rate differentials. The correlation with the 2-year spread remains fairly flat this year, but the 10-year spread has become increasingly correlated and today stands at its highest of the year (r2=0.816). Given the heightened risk that the Fed purchases more long-term assets, it would not be surprising if the dollar-yen correlation with the S&P 500 turns negative again.

Color on the Currency Reform for Fair Trade Act

The US House Ways and Means Committee approved the Currency Reform for Fair Trade Act before the weekend. The full House of Representatives will vote on the measure, and likely approve it on Wed.

It then goes to the Senate. The Senate version is a bit different and would need to be reconciled with the House version, if it passed the Senate. The word from Washington is that the Senate is less inclined to take up the measure before leaving for the pre-election recess on Oct 10.

Markets Today

The news stream from Europe coincided with the technical need of a correction after the early test in Asia on the $1.35 level, which coincides with a 50% retracement of the euro’s decline in the Nov 09-May 10 period. The news stream of EC concerns, tension between those who want for central authority in Europe and those that don’t, and problems in Ireland is hardly surprising and seems as if this was used to take profits/shake out weak longs.

The Irish government is increasingly desperate to stop downward spiral, underscored by the 1.2% quarter-over-quarter decline in Q2 GDP. On Thursday it is expected to present the final costs Anglo-Irish bailout.

Thumbnail Sketch of Capital Markets on Monday

The US dollar is consolidating last week’s losses in mostly quiet turnover. The euro is the weakest of the majors. It was turned back from the test on the $1.35 area following media reports that the EC lacks confidence in three German lenders (Der Spiegel) and that focus on an unresolved fissure at the heart of Europe (Wall Street Journal).

News that Moody’s cut Anglo-Irish bank’s unguaranteed senior debt to BAA3 from A3 and kept its senior debt on review for a possible cut sent the euro to session lows near $1.3425. The other major currencies are quiet in fairly narrow ranges. Despite the news stream, the tone feels largely corrective in a nature. There was no sign of BOJ intervention and the dollar was confined to a little more than a 12 tick range on either side of JPY84.25.

Update: India, Brazil, Mexico

India: Earlier today India lifted the cap on foreign ownership of government and corporate bonds. This had been anticipated, but it runs counter to the rash of media reports suggesting that rise of beggar-thy-neighbor policies after last week's BOJ intervention. Foreign investors can now hold as much as $10 bln worth of Indian government bonds, which is a doubling of the ceiling.

The ceiling on infrastructure corporate bonds was raised by $5 bln as well to $20 bln. Meanwhile, note that the recent data from the equity market suggests foreign investors have bought around $17 bln of Indian equities in the first eight months of the year, which is a 60% increase from the same 2009 period. The dollar has broken the large triangle chart pattern to the downside against the rupee and is now off about 4% this month alone. It is at INR45.25 today. The next key area of support is seen near INR44.0.

Market Shrugs Off Good Durables Data and Sells Dollars

Despite the soft headline, US August durable goods orders report was stronger than expected but this has been insufficient to spur a recovery in the dollar. Nevertheless, the durable goods orders are consistent with the recent string of economic data suggesting that the US economy might be stabilizing after the disappointing Q2.

The July series was also revised higher. Excluding transportation orders, durable goods orders rose 2% compared with market expectations for a 1% rise. The shipment of non-defense capital goods, excluding aircraft, is used to forecast GDP. It increased 1.6% in August after a revised 0.1% rise in July. This had initially been reported as a decline. Inventories rose 0.4%, but the stock/shipment ratio is still a lowly 1.58:1 from 1.55:1 in July.

Euro Outlook: Drivers, Direction and Degree

As the third quarter winds down, it is helpful to consider the outlook for the euro-dollar exchange rate in the period ahead. Three dimensions are of particular interest, drivers, direction, and degree. We place our conclusions first, and then provide the chain of reasoning.

Conclusion

After rallying about 6.25% since September 10, the euro may enter a consolidative phase before advancing into the $1.38-$1.40 area in the first half of Q4. However, the euro may then surrender those gains in the second half of the quarter, as QEII is discounted (or not delivered at all), and the loss of economic momentum in Europe, ahead of a 2011 fiscal contraction, keeps debt restructuring fears elevated. The increased possibility that the EFSF has to be drawn upon may also spur speculation that the ECB may not be in a position to remove its emergency liquidity provisions; . and indeed may have to actually embark on either more bond buying or taking some additional measures. All this may leave the euro trading around $1.30, if not lower, at year's end.

Friday's Drivers: Japan and IFO

Japan’s markets re-opened earlier today after yesterday’s holiday. Given the recovery of the yen in recent trading, the market was particularly sensitive to the threat of intervention.

After a quiet start to the Asian session two things happened around the same time. First, Reuters reported talk that the BOJ Governor was preparing to resign. This is seen as yen negative on the grounds that Shirakawa’s replacement could only be more aggressive in terms of intervention (although it is not the BOJ’s call) and other stimulative measures.

Dollar Heavy

The US dollar is broadly weaker as the week draws to a close. The feature during Asian hours was speculation of BOJ intervention and rumors that the governor of the BOJ was going to resign. The dollar rallied to JPY85.40 before returning to the JPY84.20 area, new marginal lows since last week’s intervention.

Zloty Leads EMEA Lower

The Polish zloty is the weakest of the central and east European currencies today. News that the cental bank had considered hiking rates 50 bp at its last meeting, but decided to leave rates steady last month at the record low 3.5%, has spooked the Polish bond market and this in turn is weighing on the stock market, pushing it down from five month highs.

Color on Weekly Jobless Claims

The weekly jobless claims are not often the stuff that moves the foreign exchange market, but the disappointment with today's data is noteworthy and hitting the the fx market as the foreign currencies began recovering from the profit-taking earlier today.

What makes today's report particularly important is that it coincides with week that the non-farm payrolls survey is conducted. Not only was the weakness more than expected, but there was new of additional deterioration. There was a large increase in those getting extended/emergency compensation benefits (+208k to 5.17 mln for week ending Sept 4).

Europe, Australia, China

The most important economic report today was the euro zone’s flash September PMI. It was weaker than expected and suggests that market participants may not have adjusted their expectations adequately after the robust growth posted by the region in Q2. Manufacturing reading came in at 53.6, down from 55.0 in August. The consensus had expected a milder pullback to 54.5. The service sector posted a steeper decline to 53.6 from 55.6, while the consensus had expected a 55.5 reading.

German data was especially disappointing and this is important because it is Germany’s strength that overwhelmed the some real regional weakness in the aggregate data. Germany’ manufacturing PMI fell to 55.3 from 58.2 and the service PMI dropped to 54.6 from 57.2. Output and orders in both sectors were weak. To be sure these readings are consistent with moderate growth, but they point to the next series of reports in the weeks ahead have downside risks.

Dollar Enjoys Upside Correction, Look to Fade

The US dollar is recouping some of its recent losses against most of the major and emerging market currencies. Softer than expected New Zealand GDP, followed by the disappointing euro zone flash PMI, the renewed widening of interest rate spreads in Europe and heavier tone in the equity markets appears to have helped spark what appears to be largely corrective price action in the foreign exchange market, with the euro and dollar-bloc absorbing the bulk of the pressure.

China, Japan and the US

US President Obama is scheduled to meet Chinese Premier Wen tomorrow on the sidelines of the UN meeting. Reports also suggest a bilateral meeting with Japanese Prime Minister Kan may take place.

Even though the meetings will be separate, the heads of state of the three largest economies in the world will meet. There is much focus on the yuan and some have suggested that BOJ intervention last week was aimed just as much at the yuan-yen rate as the dollar-yen rate. China is Japan's largest export market. The intervention appeared to be a little less than the amount of Chinese purchases of Japanese bonds this year.

Asian Currencies Rock

Excuse the pun, I'm may be getting up there in age, but I still think I have a sense of humor.

Holidays in Taiwan, China and South Korea closed those local markets but this simply shifted global investors focus to Malaysia, Thailand and Singapore.

The ringgit and baht recorded new 13-year highs, while the Singapore dollar made new record highs. Global investors recognize the attractiveness of Asia based on generally favorable dynamics of relatively strong growth and some growing inflation pressures.

Fed and the Dollar

Several forces had begun working against the US dollar over the past couple of weeks. Our work has tended to emphasize the sifting interest rate differentials, market positioning and technical factors. The FOMC statement further pushes the market in the direction it was already headed.

The market’s response to the FOMC statement, taking 10-year Treasury yields down 13 bp with more follow through in today, and new record low 2-year yield seems as if the Fed announced that it was indeed embarking on what has been dubbed QEII. Indeed a Reuters poll of primary dealers found 10 of 16 expect the Fed to buy more Treasuries compared with 9 0f 16 at the start of the month. Seven see the Fed beginning as early as Nov. The Fed’s heightened concern about deflation (the undershooting of inflation) probably has received the most attention.

Capital Markets Overview

The US dollar continues to trade heavily in the aftermath of the FOMC statement that underscored the Federal Reserve’s readiness to move. Although activity has been choppy the direction is clear. The euro joined the other major currencies by moving above its 200-day moving average yesterday. Follow through buying today has lifted the euro through its August highs. Even the yen, where intervention fears had kept the buying in check has strengthen and is at its best levels against the dollar since the actual intervention took place (~JPY84.50).

Consensus Right on FOMC, Dollar Slumps

The FOMC statement was in line with the consensus expectations, officials have left the door open to additional easing if necessary. Even if the staff revised down GDP and inflation forecasts and unemployment up, the Fed sticks with its assessment that the conditions are in place for somewhat stronger growth. The Fed did tweak its inflation assessment noting that recent data is "somewhat below" the desired level. The exceptionally low rates for extended period of time mantra remains intact. Hoenig continued to dissent but failed to convince others. Those that expect the Fed to engage in an substantial round of long term asset purchases will take the Fed statement in stride and won't substantially alter their views.

CNBC: Analyze This, Fed's Move

Brazil Getting Serious about BRL

Brazilian officials are getting more serious about curbing the real's strength. First, the central bank appears to have stepped up the amount of intervention and has been conducted two auctions a day to buy dollars since Sept 8. Local contacts estimate intervention to have run $1 bln a day for most of the last week. To put that in perspective, in the Jan-Aug period, the central bank appears to have bought about $18.6 bln. That compares to $7.3 in the same period last year.

Second, finance officials have threatened to intervene in the futures market-reverse currency swaps--. These were last conducted in May last year. Third, Finance Minister Mantega yesterday authorized the sovereign wealth fund to buy dollars.

It is All About the Fed

Today’s FOMC meeting is the main event of the week. The focus is of course on the statement. The consensus expects language that underscores its willingness to adopt additional measures if necessary. The discussion about those additional measures has focused on additional Treasury purchases. A Bloomberg poll of 1400 subscribers found that roughly 2/3 thought the Fed was “likely” or “fairly likely” to buy bonds this year and roughly the same percentage thought it would be ineffective. A consensus expects that the bond buying will be implemented incrementally, maximizing the Fed’s flexibility.

The expansion of the Fed’s balance sheet, dubbed QEII, could be justified on the grounds that based on the Fed’s own growth, unemployment, and inflation forecasts, its dual mandate of full employment and price stability is unlikely to be achieved. The Fed has tools at its disposal, few arguably as powerful as its balance sheet.

Dollar Mixed, Euro in Play

The US dollar is trading narrowly mixed against most of the major currencies ahead of the FOMC meeting. The euro’s recovery, after disappointing price action late Friday and yesterday, has brought it back to within striking distance of five-week highs set last week. Favorable reception to peripheral European bond auction helped extend the already bid euro gains. Euro strength on the crosses is also a clear theme today, with purchases against the yen helped the dollar find some bids in front of JPY85.25, a three-day low and the lower end of the range seen since intervention.

The euro has now convincingly broke through the GBP0.8400 area, for which there had been a battle in recent days. This allowed sterling to extend yesterday’s losses against the dollar, support in the $1.5480-$1.5500 band may be sufficient to stem the pressure today. The dollar-bloc is consolidating yesterday’s gains and the emerging market currencies are generally firmer.

Impact of Yen Intervention

Many people, including the governor of the central bank of South Korea, claim that unilateral BOJ intervention will not work. And yet it has. Without repeating its operation, the yen remains pinned near the intervention-inspired lows.

In addition to the spot market reaction--the developments in the options market suggest another dimension of the BOJ success (thus far). Implied volatility has fallen from about 12.7% prior to the intervention to 11.2% today. This is the lower end of where 3-month dollar-yen vol has traded in the past four months.

NY Sees Widening European Spreas and Sells the Euro

European investors seemed unperturbed by the new strains in the European bond market and had bid the euro to $1.3120. North American traders seem more concerned as they were before the weekend. The euro has moved back toward the session lows--set in thin early Asian activity (Japan markets were closed) near $1.3035. Irish and Portugal bonds are under the most pressure. Irish 10-year bonds yields are up 18 bp and Portugal's 10-year yield is up 25 bp. Both countries are seeking to sell bonds this week (tomorrow and Wed respectively). Both countries are paying a record premium over Germany. The EU is quoted on the news wires saying that Ireland needs a "sizeable effort" to reduce its deficit. Irish officials have played down speculation that it will have to tap the EFSF/IMF support.

The euro is not only failling against the dollar, but it is slipped against sterling, having been turned back again from the test on GBP0.8400 and against the Swiss franc. The euro has lost nearly 2% against the Swiss franc since the pre-weekend high of almost CHF1.34.

Pace of Equity Flows into Asia are Accelerating

Asian equities have been a market darling this year, but the pace of inflows have increased in recent weeks.

At around $534 mln, foreign inflows into Indonesia this month after nearly a quarter of the entire year's. The $222 mln inflow into Philippine shares already this month is nearly half of the year-to-date amount. Foreign investors have bought about 2.9 bln of Korean shares this month, which is nearly 30% of 2010 inflow. Thailand has taken in about $390 mln, which is a little more than half of the year-to-date figure. Taiwan is the most impressive, however, the $2 bln inflow this month is nearly 4-times greater than the inflow in the first 8-months of the year.

Europe, FOMC, Sino-Japanese Rift

News reports appear to be playing down the fears from the end of last week that Ireland and Portugal may have to turn to the IMF/EU for support. Of course there will be official admission until the very last minute. The 440 bln euro European Financial Stability Facility is designed for this eventuality. Just today Moody’s assigned triple-A rating to the EFSF. With nearly three quarters of the euro zone members not possessing the coveted rating themselves, how can the EFSF? Our understanding is that it will limit the loans to about 80% of its guarantees or about 350 bln euros. Even in this environment, this week’s periphery sovereign supply should be relatively easily absorbed.

The market shows a good appetite for high yielding bills and this includes Greece bills sales tomorrow. The challenge of the week may reside with Ireland. It will be selling 4- and 8-year bonds tomorrow (1.0-1.5 bln euros).

Monday Overview

The US dollar is mostly lower, surrendering some of its pre-weekend gains, against most of the major currencies. Sterling is the notable exception. It is heavy in the wake of a drop Righmove’s house price index, for the third consecutive month and some mortgage and money supply data (M4 contracted by 0.2%).

Japan’s markets were closed today. The dollar continues to be confined to narrow trading ranges. Japanese exporters and margin traders are thought to be capping the greenback near JPY86, while fear of intervention is provided support near JPY85.50. The Australian dollar starts the week off with a bang, as hawkish comments by the RBA Governor keep the door open to additional rate hikes.

Observations Early in the Pacific Century

The economic historian Arnold Toynbee argued that civilization began in the East, expanded around the world, and will return to the East. Even if expressed somewhat differently, many people seem to believe that the 21st century will be a Pacific century.

The center of the world economy for the last couple of centuries has been the Northern Atlantic. This has shifted to the Northern Pacific. Since the early 1980s, trade volumes going across the Pacific have been greater than that crossing the Atlantic.

Key Forces and Implications

The summer lull in the foreign exchange market ended abruptly this week and the reverberations will likely carry into next week’s activity. As the week draws to a close, it might be helpful to summarize them and draw out some implications.

BOJ Intervention: The first intervention in six-years, and what still appears to be a record single day amount, managed to lift the dollar three yen. There has been some international criticism, but not from ministers of finance, central bankers, or of course prime ministers. U.S. Treasury Secretary Geithner did not address the intervention in yesterday’s appearance before the Senate committee. With the intervention funds settling today, and no offsetting BOJ operation to mop it up, it still appears to have been unsterilized.

Quick FX Overview

The US dollar is mostly softer, but consistent with this week’s developments, the Japanese yen and Swiss franc are laggards. Additional intervention was not seen and the dollar has held above the JPY85.50. Japanese exporters are thought to have been helping provide a cap in front of JPY86.00.

The euro and sterling are trading near 5-week highs. Look for the euro to now have support near $1.3050 as it advances toward the $1.33 area in the coming days. Sterling is keeping pace with the euro and, assuming support ahead of $1.5550 remains intact, it will likely eat through the offers in the $1.5730-50 band and stretch another cent or two. The dollar-bloc is bid and the Australian dollar is at new multi-year highs.

SNB Steady CHF Hit

The Swiss franc is getting crushed. The SNB kept its three-month LIBOR target at 25 bp. It revised up this year's growth forecast to 2.5% from 2.0%. The government's forecast is a bit higher at 2.7%. The inflation forecast was cut to 0.7% from 0.9%, but even more telling was next year's inflation forecast was cut to 0.3% from 1.0%. Indeed it warns that inflation can slip into negative territory in early 2011. It says the economic recovery is not yet sustainable and this may dampen ideas of a hike before the end of the year. It does recognize the long-term risks posed by the low interest rates that are appropriate now. The dollar was down at CHF0.009933 on Tuesday and now is trying to convincingly move through the CHF1.01 level. Additional resistance is seen in the CHF1.0140-60 area. The euro is rallying more than 1% against the Swiss franc and the 5 and 20 day moving averages are abot to corss to the upside for the first time since mid-Aug. Lastly, note that the pullback in the Swiss franc may help support Eastern European currencies, especially HUF and PLN.

Fcous on Yen, Euro, Sterling and Swiss Franc

It does not appear that yesterday’s intervention has been followed with more action today. Some market observers will be suspicious for a bit every time a Japanese bank buys dollars. There was no doubt about yesterday’s operation and it was quickly confirmed by officials. Strong domestic pressure was brought to bear on officials for the intervention.

The Kan government needs to show it is responsive. There may be a time and place for strategic ambiguity, this not one of them. Officials are claiming success for their unambiguous operation. It seems to have been fairly expensive for Japan. The Nikkei reports, with citing sources, that intervention yesterday was a single-day record in excess of JPY2 trillion (~$23.3 bln). This would be above an informal survey of estimates which were largely in the $10-$20 bln range, which is something on the magnitude of 10-15x more than the initial reports coming from Tokyo had suggested. There has been some official suggestion that the BOJ will use the funds to provide market liquidity suggests the intervention will not be sterilized (offset by issuing financing bills). The BOJ did skip its money market operation. The initial read of money market conditions would be consistent with intervention in the JPY1.75-JPY1.85 trillion range.

Quick FX Snapshot

The US dollar is trading broadly mixed against the major foreign currencies. It is consolidating yesterday’s intervention-inspired losses against the Japanese yen. There was no clear sign of intervention today and the greenback has been confined to around a quarter yen range on either side of JPY85.50. The euro is extending its recent gains, with the help of good buying on the crosses, has overcome the offers near $1.3050. Although intra-day technical indicators are over-extended, we suspect a more pronounced shift of buying euro weakness rather than selling into strength ahead of next week’s FOMC meeting.

Sterling is underperforming following the disappointing retail sales (-0.5% vs consensus +0.3%). The better offered dollar may conceal the extent of sterling’s weakness, but watch its performance against the euro. A convincing break of GBP0.8400 may be significant.

US Industrial Production Hints At Soft Patch Easing

The 0.2% rise in US industrial output was in line with market expectations and there did not seem to be much of a market reaction. Nevertheless, the report is yet another piece of news that suggest that the soft(er) patch the US hit in Q2 is slowing easing. May-July series were revised lower, but that still seems consistent with the soft patch easing.

Manufacturing output, the key element of the report for most investors, rose 0.2%, but the market already knew that auto output fell. There was a surge in auto output in July (~9.5%) as some plants were not closed for the summer,which is often the case. The new information really was that excluding autos, manufacturing output rose 0.5%, the best since May.

What You Need to Know about BOJ Intervention

The main development has been Japanese intervention; the first such operation in six years. Although there has been much speculation of the likelihood of intervention, hinted at by stepped up verbal warnings by officials, but following the defeat of Ozawa in his leadership challenge, the immediate threat of intervention appeared to slacken and many market observers had pushed back the “expected” intervention until closer to JPY80 and maybe the start fo the new fiscal half year on Oct 1. In this sense the intervention caught the market wrong-footed.

FX Update

The US dollar is firmer against the major foreign currencies, but the main interest today is on the first Japanese intervention in six years that has succeeded in driving the greenback through the JPY85.00. This appears to have weighed on the Swiss franc as well, which also is among the weakest performers today.

For its part, the euro has been consolidating the Mon-Tues sharp gains. Initial support is seen near $1.2750, but look for North American to probe the offers that are thought to lie near $1.3050. Yen weakness has persisted through the European morning, even though the intervention appears to have ceased. The dollar rose to JPY85.54 before the momentum faltered. Additional resistance is seen near JPY85.75 and it seems likely that North American participants may try to test the resolve of Japanese officials.

Dollar Slumps

Stronger than expected US retail sales and business inventories fanned the risk appetites. Speculation that the SNB could raise rates this week and new attention on a WSJ story reporting that a US investment house expected the Fed to step up their bond purchases in November has pushed the foreign currencies higher. We have played down this possibility because:

Japan to Help California ?

Japan finds itself in a bind. Although Japanese portfolio capital outflows have been strong in recent weeks, they have not been sufficient to offset the purchases of yen. Japan needs the yen to be sold. On the other hand, some US states need funds. One way to square the circle emerged late yesterday. The Japan Bank for International Cooperation offered to lend the state of California money to help pay for a high-speed train that is expected to cost as much as $40 bln.

Key Drivers on Tuesday

There are three key developments today:

First, Japan’s Prime Minister Kan won the DPJ party leadership contest against Ozawa. Ozawa had been a advocating material intervention and new fiscal stimulus. His defeat reduces those risks and has been a factor helping lift the yen today. The rating agencies quickly responded. S&P indicated it would maintain Japan’s rating, but that the quality was “slowly sinking”. Fitch said that the continuity of the Kan Administration was not something that drives its assessment, but it cautioned that a DPJ split could be negative for the ratings. Japan-watchers will be closely monitoring the potential cabinet reshuffle to see what happens to Ozawa supporters. If they are forced out, it would increase the likelihood that Ozawa himself would bolt. The yen may have also received a boost from speculation that China is not alone in buying Japanese paper to diversify reserves. Market contacts report that talk suggests that Singapore and Malaysia may have also done so.

Dollar Mostly Firmer

The US dollar is mostly higher as a result of disappointing German, UK and New Zealand economic data. However, Prime Minister Kan succeeded in holding off the challenge at the DPJ leadership contest, easing the threat on the margins of intervention, which helped lift the yen to new 15-year highs against the dollar. Like the yen, the Swiss franc also drew succor from the reduced appetite for risk and the dollar briefly traded through CHF1.00 for the first time since late last year.

Euro support is seen near $1.2800 and sterling already successfully tested support near $1.5340. Risk-off sentiment may in some ways be seen as a correction to yesterday’s near-euphoria. Currencies perceived as leveraged for growth, the dollar-bloc, the Scandis, and most emerging market currencies are on the defensive.

Major Foreign Currencies Firm, Last Week's Highs Beckon

The combination of news (US, China and Basel) have reduced concerns about global growth and the risk of a double dip. This has seen risk appetites increase further at the start of the week. The major foreign currencies have trended higher through the North American morning and are poised to challenge last week's highs. The euro faces initial resistance near $1.2877 and then last week's high, which was set last Monday near $1.2920. Sterling has been lagging. At $1.5433, it is a cent off last week's highs, but good demand emerged earlier on the dip toward $1.5350. Against the Swiss franc, for its part, is within a stone's throw of last week's CHF1.0060 low.

Preview: August US Retail Sales Data on Tuesday

The US will report August retail sales data tomorrow. The consensus is for a 0.3% rise on both the headline and excluding autos. We already know that auto sales were soft and ICSC chain store sales were ok (3.2% vs 2.8% year-over-year). However, a consensus number will likely be seen as further confirmation that that exceptionally soft patch the economy had slipped into (May and June retail sales contracted) has eased.

Brazil Extends Rally

The Brazilian real is off to a firm start, promising to extend its rally for the fifth consecutive week--something that it has been unable to do in the past five months. There are four drivers and they may, taken together, rise the ire of officials who want to prevent further deterioration of the current account position. In July, Brazil's 12-month current account deficit stood at $43.2 bln. In July 2009, the 12-month c/a deficit was about $18 bln.

Growth Story and Basel Drive Markets

One of the most important developments over the past two weeks has been the easing of the summer’s anxiety about the pace global growth.

The important US economic reports include the August manufacturing ISM and the better than expected jobs data (and back month upward revisionsin private sector job creation). To this list, we can add the pre-weekend July wholesale inventory data. The consensus called for a 0.4% increase. Instead they rose 1.3% and the June series was revised to show a 0.3% rise rather than 0.1%. The fact that the inventory/sales ratio remains low (1.16 vs 1.27 a year ago) suggests the accumulation of inventories is intentional and points to a source of possible upward revision in Q3 GDP estimates.

Dollar Down, Equities Up

The US dollar is broadly lower to start the new week as the markets respond positively to the somewhat stronger than expected Chinese data reported over the weekend and the Basel III proposals which allow an eight year implementation period.

Contrary to pre-weekend speculation there was no Chinese rate hike or intervention by Japan. The euro’s advance appears to be stalling after the Asian gains were extended in Europe to $1.2835. Still, without fresh trading incentives in North America today support in the $1.2750 area should remain intact.

Insight into Next Week's TIC Data and Japanese Activity

The US Treasury will report the July TIC data at the end of next week. Japan's July capital account figures may shed some light on what to expect. These figures show that Japanese investors bought JPY3.6 trillion (~$42.8 bln) of US Treasuries.

Admittedly the Japanese data is not directly comparable with the TIC data which is derived from transactions coming through the US financial system. But, the Japanese purchases were exceptionally strong. It was the second highest monthly purchases behind the Oct 01's JPY3.72 trillion, since the This is also more twice the monthly average in the current fiscal year.

The Yen Conundrum

Seventy years ago next month, Winston Churchill described Soviet foreign policy as a “riddle wrapped in a mystery inside an enigma”. That now may be apropos of the Japanese yen.

Japan is a country that appears to be literally in decline. The population has begun shrinking, as has the work force. It has been almost 21 years since the Japanese stock market peaked. The overnight rate has been close to zero for the better part of 15 years. Deflation continues to grip the economy, which is plagued with slow growth. In fact despite the 1.5% expansion reported in the April-June quarter, in nominal terms, that is when unadjusted for prices the Japanese economy contracted by 0.6%. The lost decade has turned into two.

China, Yen, Sweden Observations, US-German Rate Update

China is the main talking point today. In an unusual move China brought forward by a couple of days the release of its CPI and industrial production figures from September 13 to tomorrow September 11. The shift to a weekend release is even more unusual and it has set the chins wagging.

There is speculation the data will be strong, especially the CPI, and that they PBOC needs this for “fundamental cover” to hike rates before the markets open on Monday. While acknowledging no compelling explanation for the shift, the speculation seems a bit of a stretch. Such “cover” is unnecessary. China reported today that property prices in August rose 9.3% from a year ago, which is the slowest pace in six months. The yuan did rally, perhaps helped by such speculation; perhaps helped by the rapprochement that seems to be the outcome of the US senior official visit. China also reported August trade figures. The $20.03 bln surplus was considerable smaller than the market expected (~$27 bln) and the July surplus of $28.7 bln.

Dollar Soft, Yuan Rallies

The US dollar is firm against the safe-haven yen and Swiss franc but is winding down the week on a softer note against the euro, sterling and the dollar-bloc currencies. Most emerging market currencies are firmer too in an environment in which investor anxiety levels appear to have eased. After initially slipping in Asia to new lows here in September near $1.2642, the euro recovered with the help of scatter talk of official or quasi-official interest. Euro demand on the crosses, especially the yen and Swiss franc was also reported. The dollar traded as high as JPY84.30 in Asia, the upper end of this week’s range, but encountered good offers. China is very much part of today’s foreign exchange story. The yuan appreciated 0.2% against the dollar, the most since late June and the reference rate for the yuan was the strongest in two years.

Equity markets in Asia were mostly higher, but many were closed for holidays today, including India, Malaysia, Philippines, Singapore and Indonesia. The MSCI Asia-Pacific Index edged 0.3% higher, which was the average daily gain over the course of the week. The Nikkei’s 1.55% advance led region, perhaps encouraged by the strong upward revision in Q2 GDP to 1.5% from 0.4% (which was largely anticipated).

Dovish Brazil, but Firm Real

The market is talking about the dovish cast to the minutes of the recent central bank meeting. It seems to be among the strongest signals to date that policy is on hold. The market had already pushed out expectations for a hike into next year and now are scaling even those back a bit.

The dovishness of the minutes has ben further driven home by the slippage in the IPCA inflation measure for August reported today. It slipped to 4.49%, the lowest in 8-months and down from 4.6% in July and a peak near 5.25% in April. It is the first time this year that inflation fell below the 4.5% mid-target.

Norway and Peripheral Bond Markets

Norway's government pension funds is the second largest sovereign wealth funds in the world with around $450 bln under management. Abu Dhabi is thought to have the largest sovereign wealth fund. The finance minister indicated that it has bought peripheral European bonds (Spain, Greece, Italy and Portugal. Ireland was note cited). Although many observers are regarding this as new news, it is not. On August 13, one of the fund managers had revealed the Greek bond purchases.

The comment from the Norwegian fund managers did not reveal the amount of peripheral bonds purchased or the duration. However, consider what has happened in the past month--Greek 10-year yields are up 141 bp, Portugal is up 75 bp, while Spain and Italy are largely flat.

BOE, Japan, Australia, South Korea and India Featured

The Bank of England kept rates on hold as widely expected. While there has been much discussion, if not consternation, over the possibility of QEII in the US, many observers have missed the creeping talk, in part encouraged by BOE Governor King, of another round of asset purchases by the BOE. Similar to the Fed, if it does transpire, most are not expecting it imminently. Talk in the UK is that a window of opportunity (necessity?) may open Q1next year as fiscal contraction kicks in.

Meanwhile, one of the reasons that the BOE explains some of the inflation pressures that have required it to formally explain itself to the Treasury is sterling’s past decline on a trade-weighted basis. That decline of sterling, however, has not been sufficient to help the trade account very much, underscoring our sense that officials and investors often exaggerate the role of exchange rates. The UK’s July trade deficit of GBP8.67 bln was nearly 20% larger than the market expected after a GBP7.5 bln deficit in June. The deterioration was roughly spilt between EU and non-EU. Like the US and Canada experienced in June, the UK recorded an import surge in July. Imports rose a sharp 3% on the month, while exports were off 0.9%.

Consoldiative Tone in FX, Equities Firmer

The US dollar is mixed today as it consolidates against the euro and Swiss franc, remains heavy against the yen and is performing best against sterling, especially following the unexpected marked deterioration of the trade balance. Euro buying against sterling and a healthy reception to the Irish bill auction helped the euro recover from the test on yesterday’s lows near $1.2660. Euro needs to surmount formidable resistance in the GBP0.8280-GBP0.8300 band to boost the near-term outlook. Strong Australian jobs data helped drive the Australian dollar to new highs since 5-month highs. The dollar has thus far been confined to yesterday’s range against the yen and has traded in a 25 tick range on either side of JPY83.75.

European Central Banks may be Stepping Up Bond Purchases

With peripheral European bond spreads under pressure, it is not surprising to hear more talk of purchases by European central banks. What is slightly different about the talk today is that:

1) The purchases are said to involve at least three peripheral countries, Portugal, Greece, and Ireland, usually the talk has focused on 1-2 countries.

German Shines Dulls, BOC Meetings, Japanese Flows

European policy makers have successfully addressed the spring’s liquidity crisis. Portugal managed to hold a decent bond auction today even as the premium over Germany widened to new record levels. The underlying solvency issue—or more precisely—the need to restructure the sovereign debt—has not been addressed. This leaves Europe particularly sensitive to growth as a key. The strength of the German economy has obscured the weakness in the region, but that appears to be one of the key shifts in market psychology in recent days, almost a bizarro version of the slightly less angst in the US following the manufacturing ISM and employment data last week.

Yesterday’s news of a disappointingly large drop in German industrial orders (-2.2%), today Germany reported an unexpected drop (1.5% ) in July exports and only a 0.1% rise in July industrial production—one tenth of what the consensus forecast. The data is not exceptionally worrisome. Taken together it simply underscores that the strong pace of Q2 growth may have been the peak and that the slower German growth going forward will allow the weakness of much of the rest of the region to become more evident.

Dollar Slips

The US dollar is mostly lower today, with sterling leading the way. Corporate acquisitions, or talk of them at any rate, with the help of the second consecutive rise in the Halifax home price index, and as expected manufacturing data (+0.3% in July) helped sterling bounce 2 cents off yesterday’s low to test $1.55 today before running into offers. The selling pressure seen on the euro since Monday’s move to almost $1.2920 continued, but the momentum appears to be fading and some near-term recovery toward $1.275 seems likely. Japanese officials appear to be stepping up their rhetoric, but the market hasn’t blinked, talking the dollar down to new multi-year lows. The JPY84.00-20 area looks like the near-term cap.

European Woes Continue

Coming back from the Labor Day holiday, US investors have been caught a bit off guard by the reversal of sentiment toward Europe. The euro had rallied in the immediate aftermath of the stronger than expected US jobs data ostensibly on a greater appetite for risk. There was some follow through early yesterday and then only lower.

The Dollar's State of Play

At the start of the summer, the two legs that had supported the dollar had given way. The European financial crisis eased and the US economic momentum flagged. The summer months saw these developments extend.

European countries on the periphery have not been frozen out of the capital markets. They have sold their bonds (in Greece’s case, bills) at higher, though not exorbitant rates. At the same time economic growth in the region accelerated markedly in Q2 over the near stagnation in Q1. On the hand, the vulnerability of the US economy is sufficiently obvious that the Federal Reserve adopted what is essentially an easing bias and will resist a passive contraction of its balance sheet. The Obama Administration is in the process of a unveiling a new infrastructure renewal, business investment, job-creating package, which, if as suggested may be worth as much as $100 bln is thought too small to call a second stimulus. Its approval by Congress is not clear cut amid partisanship ahead of the November mid-term elections.

Market's Focus Shifts From US Economy Back to Europe

It as if market participants can focus only on one of the key drivers of financial markets at a time. From last November through May, European financial woes were paramount. As the EU and ECB innovated and, we have argued bluffed (through exaggerating the size of the financial program in mid-May) the liquidity pressure eased and fears of the imminent demise of the euro zone eased, the market turned its attention to the marked slowdown of the US economy. This saw the dollar generally trend lower in the June-July period.

Euro Slides, risk Aversion Rises

The US dollar is broadly higher against most major and emerging market currencies today, with the yen and Swiss franc being the notable exceptions. With last week’s US employment data taking the immediate focus off the US and the potential for QEII, the market has been able give full attention to the negative European developments, which include new questions about the stress tests, concerns over the amount of capital that will need to be raised under Basel III, and reports suggesting euro zone governments will seek to raise 100 bln euros this month, roughly twice the amount raised in August.

Weak German manufacturing orders were sufficient to push the euro through support near $1.2750 and, although short-term technicals are over stretched given the nearly 2 cent pullback from yesterday’s highs, new lows are likely in the North American session. The $1.2580-$1.2600 is seen a critical support and the European high near $1.2820 may cap upticks.

CNBC: Markets Roundup

This is BoJ Intervention Window (if it really wanted it)

The market has been rightly skeptical of the efficacy of possible BOJ intervention. Part of the argument is that it would be fighting the tide and market forces. However, the better than expected US employment data has spurred a sharp drop in the yen. If Japanese officials really wanted to intervene, this would be the proverbial golden opportunity.

Better than Expected Jobs Data--Dollar Slips

The employment data was better than expected, but the dollar is not making much headway. The private sector added 62k and the July data was revised up to 107k from 71k initially. The unemployment rate ticked up to 9.6% from 9.5%.

Jobs DAta is Often Anti-Climactic

The main focus today is on the US employment report. The fact that the service sector ISM is released shortly afterwards and that, given the Monday holiday in the US, and some markets will close early and could impact the market’s reaction to the jobs data itself. Yet, while the jobs report is regarded as among the most important economic releases of the month, the significance fore the foreign exchange market may not be as great as one might expect. Let’s review the recent history.

Ahead of the Jobs Data

The US dollar is mixed in quiet trading ahead of the US jobs report. With some risk-taking is returning to the markets on the back of data this week suggesting that the pace of the slowdown may be moderating and this is lending support to the euro and sterling and weighing on the yen and Swiss franc. The general consolidative tone that emerged near midweek remains intact. The US employment data is seen by many as the likely signal of the near-term direction, but as we review below, over the last three months the market’s disappointment has not been consistently been reflected or expressed in the dollar’s performance.

More on Potential Intervention

Many had expected the BOJ to have intervened already and its absence raises the question of why haven't they. The simplest explanation is they don't think it would be effective. This is the meaning of the official comments that say that the real issue is dollar weakness not yen strength. But some do not find the straight forward explanation very satisfying.

A news wire now cited three "unnamed sources" suggesting that US opposition to intervention is preventing unilateral BOJ intervention. Really ? This seems to exaggerated the US influence over Japan. The US did not seem to look at the massive BOJ intervention in late 2003 and early 2004 favorably, yet it took place. That is to say if the political will was stronger, US distaste/objections to intervention would be overcome. The yen's rise is not simply against the dollar, as the performance of euro-yen clearly illustrates. The yen has appreciated by about 10.5% against the dollar this year and about 21% against euro. Since the end of Q1, the yen has appreciated by around 14% on a trade-weighted basis and 40% in the past two years.

Little News from US Jobs and Trichet

The two key events of the day are passing with little fanfare. The weekly initial jobless claims in the US slipped and sufficiently so as to bring down the 4-week moving average for the first time in a little over a month, but remain too close to 500k to ease anxiety very much.

The ECB left rate on hold, revised up both growth forecasts a notch and inflation. The lending facilities have been extended and the ECB will conductino special operations later this month to help ensure a smooth expiry the large long-term refi operation.

Waiting for US Jobs and Trichet

There are two sources of event risk. The first, and lesser of the two, is the US weekly initial jobless claims. The modest pullback from the above 500k reading in mid-August was a constructive development, but the 4-week moving average still ticked up to its highest level of the year (486k). It will take a weekly reading today below 482k to bring the 4-week average down (assuming no revisions).

Now of course with the monthly national report out tomorrow, the market’s reaction may be more subdued. The market’s response may be asymmetrical in the sense that a move back above 500k may elicit a bigger market response than a decline in initial jobless claims. At the same time, note that recent comments from the Fed’s Plosser and Fisher have played down the near-term need for Fed to buy more long-term assets.

Capital Markets Wednesday

The US dollar is mostly softer, though within yesterday’s ranges as market participants await the ECB’s press conference and US economic data. Sterling is under-performing perhaps being impacted by the softer string of recent data, including today’s construction PMI (52.1 vs 53.2 consensus and July’s 54.1) and the fifth consecutive monthly decline in Hometracks’ house price index. The euro is firm, but like yesterday the band of resistance in the $1.2850-$1.2875 may prove sufficient to check upticks ahead of tomorrow’s US employment report. The dollar remains pinned near recent lows against the yen, but the momentum remains stalled. Range trading between JPY83.50 and JPY85 looks set to continue. Emerging market currencies are generally firmer as the recent string of data—especially yesterday’s better than expected China’s (especially the increase in new orders) and US purchasing managers reports.

Canada and Mexico Benefit from Stronger ISM

The Canadian dollar and Mexican peso have benefitted from the better than expected US ISM and the risk-on environment. The strong gains in the Canadian dollar come even though as we noted yesterday, a BOC rate hike at the Sept 8th meeting, which previously was fully discounted, seems less likely given the string of disappointing Canadian data, doubts over the US recovery and the pullback in commodity prices.

The Mexican peso, which posted among its lowest closes for the year yesterday also rallied strongly today. The more than 1% gain comes despite some comments from a Moody's analyst warning that Mexico's security issues and the vulnerability of its oil revenue ($50 a barrel cited) may jeopardize its rating.

US Foreign Securities

The US Treasury published its annual report yesterday on US holdings of foreign securities. It is a preliminary report and the final one is expected in late October.

The basic conclusion was that at the end of last year, Americans owned roughly $6 trillion of foreign equity and debt instruments. Unlike most foreign investors, when Americans invest in foreign markets, they have traditionally preferred equity over fixed income. Roughly 3/4 of the foreign securities they own are equities. The remaining $2 trillion was largely accounted for by long term debt securities (defined as original term-to-maturity) of more than 1 year. Shorter term instruments accounted for about $400 bln. At the end of 2008, estimated US foreign securities holdings at $4.3 trillion, with $2.7 trillion in foreign stocks and $1.3 trillion in foreign bonds; leaving $300 bln in short-term debt instruments.

Will the Risk Appetite Continue Through the North American Session?

Given the slump in equity markets in August and the heightened concern of a global economic slowdown, there seems to be a collective sigh of relief, not just that the month is over, but that the economies, generally speaking, may not have performed so badly. Australia got the ball rolling with a stronger than expected Q2 GDP. Exports rose 5.6% in the quarter. The Australian dollar is the strongest currencies today, rising about 1.5% to test resistance in the $0.9050-$0.9080 band.

China’s PMI rose to 51.7 from 51.2 in July. The market expected a 51.5 reading. What investors are most interested in is the forward looking aspect and here the China news seemed particularly promising as new orders rose to 53.1 from 50.9 and new export orders rose to 52.2 from 51.2. The fact that input prices lept to 60.5 from 50.4 warns of upside risks to the upcoming inflation reports.

Growth In Australia and China Lifts Sentiment

The US dollar is broadly lower to start September as stronger data, especially from Australia and China encourage new risk taking. Yet this has not seen the yen and Swiss franc, beneficiaries of risk aversion, lose ground against the greenback, though they are under-performing on the crosses. This, coupled with the fact that some countries like the UK, Norway and Sweden, which have reported disappointing PMIs, have also seen their currencies raise against the dollar today, provides a sense that in addition to the risk-on story, there is a weak dollar bias. Given the over-stretched short-term technical studies, the risk is that if the US data disappoints (ADP and ISM), the price action could be reversed.

Global equities are rallying as the new month gets underway. The commodity sector helped lead the MSCI Asia-Pacific Index 1.1% advance. Stronger than expected Australian Q2 GDP (1.2% vs 0.9% consensus) helped lift the S&P/ASX 200 by a bit more than 2%. News that continued growth in Korea’s exports saw the Kospi rise 1.25%, and the helped lift the won by a sharp 1.2% against the dollar. Foreign investors were net sellers of both Taiwanese and Koran shares last month, but may return. European bourses are also fully participating in the rally with most major indices up 1%-1.5% near midday in London. Basic materials and consumer services and goods are leading the way, but all major sectors are advancing. US indices are called a bit more than 1% higher, though the ADP data will be out before the open of the NYSE.